This post will outline the traditional economic model of PS3 sales during this holiday season. This is basic first semester economic theory to many and just plain common sense to others. But there has been a lot of confusion about this issue, so I’d like to clarify it.
This is the fundamental supply/demand graph. The red line indicates supply and the blue line indicates demand. Notice how buyers are willing to buy more units as the price decreases and suppliers are willing to sell more units as the price increases. These two factors of supply and demand react against each other to reach an equilibrium point. This point indicates the price and sales volume that the market gravitates towards.
This fundamental theory is very applicable to traditional commodity markets where there are many buyers and sellers trading the same product such as corn or oil or labor. The PS3 market this holiday differs in two main ways:
- The available inventory is fixed. There is only one supplier (Sony) and they will only be able to provide a set amount of inventory this holiday season. Additional inventory will have to wait until 2007. The formal terminology for this is an “inelastic supply”.
- The retail price is fixed. In traditional commodity markets, the price constantly fluctuates towards the equilibrium point set by the supply/demand effects of the market. For the PS3 holiday, there is a single fixed price which is predetermined by a business and analyst group based on various business and marketing estimates. The formal terminology for this is an “inelastic price”.
There are two main potential categories of outcomes of the PS3 selling holiday:
If consumer demand is high relative to supply, there will be a shortage. Consumers are willing to pay more than the set price but there simply isn’t enough inventory to sell to them. Most economists would say that the product should have been priced higher and more inventory should be produced. The green hashed area represents the extra money that the seller forfeited that consumers were willing to spend while still buying up all inventory. Often, as seen with the 360, there will be scalpers, ebay sellers, and a gray market that attempt to capture this extra margin.
If consumer demand is low relative to supply, there will be a surplus. Consumers simply weren’t willing to buy all the inventory that was made at the price it was offered at and some inventory goes unsold. In this scenario, most economists would say the good is priced too high or there was too much of it produced.
There will be one of two scenarios this holiday. Either
- Consumers will be shocked at the high price or favor alternatives and the PS3 will languish on store shelves. This indicates that the launch price was set too high.
- Consumers will eagerly buy up all available PS3 inventory leading to shortages. This indicates that the launch price was actually set too low.
My main point that I think many don’t understand is this: If you think the launch price should be lower, then you should share the corresponding belief that there will be a significant surplus at the current price. If you think that there will be shortages, then you should share the belief that the launch price should actually be higher.
One factor not captured by this theory is public perception. While economic theory suggests that the price should be raised during a shortage, that often leads to a negative image. When the 360 launched, demand far outpaced initial supply. It probably would have sold out at twice the price. However, that would had formed a very negative perception of the product that could last long after the price dropped.